Interrelation between benchmark interest rate and currency rate

Interrelation between benchmark interest rate and Forex currency rate

What is benchmark interest rate?

How does it impact the economy?

What is the interrelation between benchmark interest rate and currency rate?

How can it be applied in Forex?

What is benchmark interest rate?

Benchmark interest rate is defined by the Central Bank (further referred to as CB) for national currency. If required, commercial banks take on a loan based on this rate. In the USA this is the interest rate, which should be reimbursed by commercial bank for overnight, or the credit for one day. Commercial banks in their turn set interest rates for individuals and legal entities they serve, but their rate is based upon rate set by the Central Bank, or, to be more precise, by the Federal Reserve System, which implements function of the Central bank. In other words, the lower the interest rate us, the lower percentage should be paid by bank's clients for credits.

How does it impact on the economy?

Central Bank applied base rate to impact on the economy. In what way? If interest rates grow, economic activity becomes slow and inflation gets down. If interest rates go down, then economic activity is fostered due to less cost of credit.

What is the interrelation between benchmark interest rate and Forex currency rate?

Growth of interest rate leads to a higher rate of national currency. That is to say, if other things being equal Australian benchmark rate is higher than Canadian (both currencies are considered to be recourse-based and if the price of raw material is stable, both economies have more or less equal conditions), then in this currency pair Australian dollar will rise in price whereas Canadian will get cheaper. AUD deposit will provide more profit in percentage than CAD does and that will boost demand for the currency with a higher percentage on deposit.

  

 

 

How can it be applied in Forex?

Change of the interest rate is never significant (as a rule, 0.25-0.50 base points), and often market anticipates possible actions of the CB (for instance, regarding pronouncements of CB representatives at various events). Occurrence of more evident alerts about change of rate seriously impacts on currency rates. Making an earlier trade with a view of changing the rate can give better profit. Large players start adjusting their investment portfolio a few months prior to announcing public data, upon that, they push currency to a certain point.

The information on currency rate is issued by CB at strictly defined time on official web-site of CB. That provides all interested parties with equal opportunities. If the decision about rate is unexpected, significant fluctuations of currency on the market start within the first minutes after announcing information. Using proper approach in this case also allows to gain profit.

Besides, there is an opportunity to earn due to the very difference between the rates of two currencies with the help of swap, namely, rollover of position overnight.